Paul L. Caron

Friday, November 13, 2009

More on 100+% Implicit Marginal Tax Rates

Following up on Wednesday's post, 100+% Implicit Marginal Tax Rates Will Create Permanent Democratic Majority:  Greg Mankiw (Harvard) blogs The Poverty Trap:

Chapter 20 of my favorite textbook has a section on antipoverty programs and work incentives. One basic point is that when multiple income-based programs are piled on top on one another, the implicit marginal tax rate can reach or even exceed 100 percent.

The chart above (source, via Kling) illustrates this phenomenon. It shows income after taxes and transfers as a function of earned income. Notice that as earned income rises from about $15,000 to $30,000, income after taxes and transfers is roughly flat. Indeed, it could even fall. The bottom line: If you are poor, the government is inadvertently ensuring that you have little incentive to try to improve your condition.

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Having studied the apparatchik phenomena for some time, I have come of the conclusion that most federal "assistance" programs are designed to ensure a permanent client base for the agency rather than actually assisting anyone.

Posted by: Jerry in Detroit | Nov 14, 2009 6:42:38 AM

Situation is worse than 100% marginal tax rates due to means tested government subsidies!

With much free time from being on the government dole, many "poor" work for cash under the table. For example, if the unreported income is $20,000, then the government subsidized net is equivalent to someone working for an $80,000 salary. Not bad for unskilled labor.

Posted by: mojo | Nov 14, 2009 6:09:07 AM

What is bad is that countries that were considered socialist and communist just a decade or two ago are now much better about incentives than the US is.

China has much lower corporate and capital gains taxes than the US. China.

Posted by: Toads | Nov 13, 2009 3:04:15 PM

Let's put this in terms of a flat tax. First $40000, you (roughly) keep it all. Interesting penalties for escaping from the subsidy black hole, though. Then let's determine how much of the 'excess' you are permitted to keep. From $40k to $140K earned income, your allowance from the government(s) grows from $40K to $100K (as best as I can tell by squinting at the graphic). So the slope of that line is (100-40)/(140-40) or 0.6. You get $40K plus 60% above $40K, the governments take 40% above $40K. That jibes with what I've added up personally over a number of years. It would be interesting to see what the percentages are for higher earned incomes.

Posted by: chuckR | Nov 13, 2009 11:19:18 AM

I don't know about other states but here in NC the problem is compounded even further -- the individual (or family) receiving many kinds of aid can't have more than $2000 in liquid assets. A major car repair or a broken appliance can easily blow through all or a big chunk of that. Yet it prevents the poor individuals from doing the very important step of putting money away to be able to weather minor financial crises. It also discourages the habit of saving so that even if these people work their way out of the poverty level, they haven't developed any saving habits at all. I am not saying that there shouldn't be an asset test -- but how about one that is a bit more reasonable?

Posted by: NC Reader | Nov 13, 2009 10:02:23 AM

The situation is almost as bad with the unemployment system.

I lost my job in the high tech industry seven months ago and took a temporary job that was only fifteen hours a week. Naturally I reported it to unemployment. The amount they took from my unemployment check was about what I made on the job so I was basically working for nothing.

I went ahead and finished the six-week job assignment, but I can see where rules like this - and in other government programs - would discourage people from seeking honest work.

Posted by: Mark | Nov 13, 2009 10:01:45 AM

The obvious solution to the "Dead Zone" is to extend the phase-outs of deductions, exemptions, eligibilities and credits and work incentives over a greater range of incomes. In this way the income less taxes plus subsidies vs. earned income would have a positive slope. Combine that with a doubling of the minimum wage and there would be far less to worry about.

Posted by: WD Kebschull | Nov 13, 2009 9:16:01 AM

I sat down and did some figuring for a family of five currently grossing 80K in Northern Virginia.

If they will eventually have to pay taxes for their middle class income, or if health care eventually becomes "free" just like public education, moving to a lower housing-cost farming area and living off the dole seems like a good bet.

By keeping their "income" to just under the poverty line, and doing a lot of stuff in cash like the ACORN people, the benefits would be tantalizing.

They could grow vegetables and raise beef, in the pattern of one of the first income-tax-escaping libertarians in this country under Roosevelt - Rose Ingalls Wilder.

Of course gun training and security systems will be necessary because society is going to come apart at the seams.

Posted by: Jane | Nov 13, 2009 7:37:18 AM

And I thought I was just lucky. Through various (perfectly legal) means I have kept the money passed through to me from my family S-Corp business right at $40k. With my various personal deductions I haven't had to pay Fed Income tax in ten years in business. So it's not that it is just perfectly legal - apparently it is set up to make it a fools game to do otherwise. It's kind of like teaching to the test. The government gets the credit and the votes without even bothering with the fallout from the fact they are doing the wrong thing. At least for us.

Posted by: Dudeboy9 | Nov 13, 2009 7:21:58 AM

If you are poor, the government is ensuring that you have little incentive to try to improve your condition.

There, I fixed it for you. Nothing inadvertent at all.

Posted by: John Bigenwald | Nov 13, 2009 7:15:09 AM

"If you are poor, the government is inadvertently ensuring that you have little incentive to try to improve your condition."

Inadvertently? By staying poor, you keep your function as a ward of the state.

Posted by: Realist | Nov 13, 2009 7:10:48 AM